Broadcom ’s AVGO 1.10% latest move left many investors scratching their heads. In that confusion may lie a buying opportunity.
In the nearly two months since Broadcom announced its plan to buy CA Technologies CA -0.05% for nearly $19 billion, the chip maker’s market value has gone down by nearly $15 billion. That equates to a 14% haircut for a stock that was already trading flat for the year—mostly due to the company’s aborted attempt to buy Qualcomm . That makes Broadcom the worst-performing stock among major chip companies so far this year. Even Qualcomm—with its many challenges still ahead—has eked out an 7% gain.
Is that warranted? Broadcom’s communication about the deal was terrible, considering that it marked an abrupt turn by the chip maker into the software business. The company held no call to discuss the deal publicly—a break from its practice with most of its past transactions.
That sparked a revolt among analysts who have typically favored the company; at least seven have since cut their “buy” ratings on Broadcom.
But perhaps the move shouldn’t have been such a shock. Broadcom’s purchase of Brocade in late 2016 included that company’s software business. And the hyper-acquisitive Broadcom was running low on options among chip makers. President Trump’s order not to pursue Qualcomm effectively took that company off the market, and the growing trade dispute with China has made other large semiconductor mergers much less palatable for the foreseeable future.
So Broadcom bet on CA, which carries more risk than its past chip company rollups. Skill at running a semiconductor business doesn’t automatically transfer to an enterprise software business. And CA—a hodgepodge of software offerings whose revenue appears to have peaked six years ago—brings plenty of challenges in its own right. Mark Moerdler of Bernstein estimates that CA’s mainframe software business, which accounts for about 85% of the company’s operating profit, will decline at a rate of 2% to 3% a year.
But Broadcom typically doesn’t buy companies at the top of their game anyway. Rather, the chip maker follows the private-equity playbook by targeting businesses with strong cash-flow and selling off the extraneous parts. CA fits this bill. John DiFucci of Jefferies said the company’s mainframe business “can be milked for a very long time.” And Mr. Moerdler said that CA’s fiscal first-quarter report earlier this month showed improving margins thanks to cost controls.
Broadcom’s fiscal third-quarter results slated for release Thursday afternoon afford a new opportunity to explain its latest shift, which the company should take. Its core business is still doing well, particularly in chips used in data center equipment. Most important, Broadcom’s stock is trading just under 11 times forward earnings, which is its lowest level in five years and also one of the cheapest plays in semiconductors. At that level, a little talk could go a long way.
Write to Dan Gallagher at [email protected]